Corporate Finance

Question 1

6 investment decision criteria

Answer 1

1) NPV
2) IRR
3) Payback period
4) Discounted payback period
5) Average accounting rate of return
6) Profitability index

Question 2

Average accounting rate of return

Answer 2

AAR = (Average net income/Average book value)

Question 3

Profitability Index (BCR)

Answer 3

PI = 1 + (NPV/Investment)

Question 4

IRR flaws (3)

Answer 4

• Assumes reinvestment at calculated rate
• Multiple IRRs are possible
• No IRR is possible

Question 5

Outlay =

NPV by equations

Answer 5

Outlay =

FCinv + NWCinv - salvage0 + Tax(sal0 - bookvalue0)

Question 6

Cash flow =

NPV by equations

Answer 6

Cash flow =

sales - costs)(1 - tax) + (tax)(depreciation

Question 7

TNOCF =

NPV by equations

Answer 7

TNOCF =

SalesT + NWCInv - Tax(SalvageT - BookT)

Question 8

NPV =

NPV by equations

Answer 8

NPV = Outlay + SUM(CF/interest) + (TNOCF/interest)

Question 9

Depreciation types

Answer 9

• Straight-line
• Double declining
• MACRS (US), Modified accelerated cost recovery system

Question 10

Accelerated depreciation effect on NPV

Answer 10

Accelerated depreciation will generally improve the NPV (will reduce tax in the early years)

Question 11

Inflation effect on tax

Answer 11

Higher than expected inflation increases real taxes - reduces the value of the depreciation tax shelter

Question 12

Multiple project evaluation methods (2)

Answer 12

1) Least common multiple of lives

2) Equivalent annual annuity